Could 2019 see the beginning of the end for the US dollar?

By John Stepek

published 24 December 2018

in Features

181223-us-dollar — Donald Trump has increasingly wielded the US dollar as an economic weapon.

It's been a grim year for markets the worst since 2008.

But the drama's not over yet. Now the US government is shutting down too.

Should you care? Or can you go back to your mince pies and crackers?

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Remember all the drama over the debt ceiling?

The US government looks set to be partly shut down until at least Thursday. You probably don't want to read a load of stuff about a foreign country's politics on Christmas Eve, and I don't blame you. So let's ignore the internal politics, and cut to the chase.

Long story short, US politicians are trying to sign off on some public spending bills. As part of the spending package, president Donald Trump wants $5bn to build that wall he's been looking at between Mexico and the US. The Democrats don't want to give it to him.

Because they can't agree on the overall spending package, a chunk of the US government has now shut down. It means a large group of federal staff will work without pay (they'll get it back once the shutdown is over) and another lot will be temporarily laid off (or "furloughed").

Does this matter? After all, we've seen US shutdowns in the past. Since 1981, it's happened 12 times.

Remember 2011? That particular debt crisis resulted in credit rating agency S&P downgrading US government debt from AAA. It was all over the front pages. All the opinion writers of the world were talking about what a disaster it was. Markets didn't like it either. They had their roughest week since the 2008 crisis.

There's no doubt it was a pointless piece of political theatre. It's always hilarious particularly in the US, where neither party even aspires to be a "small government" party any more when one side or other takes the moral high ground and says that the other lot are spending too much. And they get to use the "debt ceiling" law whereby the government has a legal ceiling on what it can spend to express indignation for a while before the ceiling is inevitably raised.

But for all the furore caused, ultimately it was pretty meaningless. The US government kept on spending. The shutdown barely dented the general business of either the private or the public sector.

So this stuff doesn't matter. Right?

Could 2019 be the year the demise of the dollar begins?

Certainly, the current shutdown, from an economic point of view, is not important. As Andrew Hunter of Capital Economics notes: "even on an annualised basis, the direct costs of a partial shutdown would only be $34bn, or 0.2% of GDP, so that would not markedly change the economic outlook for next year."

Trouble is, it might not stop there. Let's go back to that 2011 shutdown for a moment. The key factor there (and again, when the issue re-erupted in 2013) was the "debt ceiling". The tricky thing about the debt ceiling is that, while it's entirely artificial, if it's breached, it means that the US can't borrow any more money. In other words, it can't issue any more Treasuries (government bonds).

If that happens, then the US would only be able to use incoming tax money to repay any debts. It would have to start prioritising the various payments it has to make every month. And eventually it'd run out of money to pay its bills including the interest payments due on government debt.

Given that US Treasuries are seen as the safest assets in the world, that's a problem. If the US government actually defaulted on its debts even once that would send a shockwave of epic proportions across global financial markets.

This particular bone of contention has been tossed into the long grass on various occasions in the last few years. But US politicians need to agree together to raise the debt ceiling. If they don't do so by July, reckons Hunter, "there would be a risk of the Treasury missing a payment on the national debt."

Is that really likely to happen?

An underlying theme for a long time now, has been the demise of the US dollar as the world's reserve currency. I don't think this is going to happen any time soon. But let's have a think about what's changed in recent years.

Under president Donald Trump and to an extent, under his predecessor Barack Obama too, the US has increasingly wielded the US dollar as an economic weapon. The vicissitudes of the oil market and sanctions against Russia in particular have clearly demonstrated how important it is for a nation to be plugged into the dollar ecosystem in order to participate fully in the global economy.

That's one factor that might encourage countries to find alternatives. You then have the fact that the US is run by a man who famously loves using debt to build flashy empires, and is not at all averse to the idea of defaulting on said debt.

Is the US likely to default on its debt? It's almost unthinkable. But with Trump at the wheel, it's just that little bit more thinkable than it once would have been. Yes, it would take a lot for the world to lose faith in the US dollar to the point where a serious hunt for alternatives was stepped up. But I have a feeling that if anyone is up to the challenge of kickstarting that process, then it's Trump.

A prolonged US shutdown is one big risk to watch out for in 2019, says Paul Ashworth, also of Capital Economics. We'd have to agree with him.

But in the meantime enjoy your mince pies and crackers.

Money Morning will be taking a break over Christmas and Boxing Day. We'll then be running a special message from our friends over at Southbank Investment Research, who have a new service coming out which I think some of you will be very interested in it's run by a highly-respected City analyst with decades of investment experience, so keep an eye out for it.

Have a great Christmas and thanks for reading!

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.